A credible threat of entry can influence an incumbent's decisions.
Existing competitors can win sales today; potential competitors may enter if expected returns justify the risks and costs. Entry barriers limit that pressure. Examples include legal restrictions, difficult access to essential inputs, scale advantages, sunk entry costs and networks that are more useful when many users already participate. A high current market share does not by itself establish permanent protection. Explain which obstacle prevents entry or expansion and whether buyers can switch. Potential competition can discipline an incumbent even before entry occurs, but the threat must be credible.
- Actual competition
- Existing firms compete for sales now. An incumbent is a firm already operating in the market.
- Potential competition
- An entrant is a new rival. Even before it enters, an incumbent may improve its offer if the threat is credible: the rival has a realistic ability to enter and win customers.
- Barrier mechanism
- A barrier matters because it blocks something the entrant needs, such as customers, finance or access to essential supplies. Legal permission to create a company is not enough.
Why an entry threat may or may not work
Network effects
A platform becomes more useful when more people participate. A delivery platform needs customers to attract restaurants and restaurants to attract customers, making a new network difficult to build.
Sunk entry costs
Sunk costs cannot be recovered on leaving the market. Money spent on launch advertising is gone; a vehicle that can be resold is partly recoverable. Larger sunk costs can make an uncertain entry attempt less attractive.
Contestability
Contestability is the pressure created by firms being able to enter and challenge existing sellers. Low sunk costs and accessible inputs can strengthen that threat, even before a rival arrives.
Worked example: A new delivery platform needs both sides
A delivery platform has many restaurants and customers. A new platform can build an app cheaply, but restaurants are reluctant to join without customers and customers are reluctant to join without restaurants. Existing contracts also limit restaurants using rival platforms.
- The main barrier is not necessarily coding the app. Each side values participation by the other, so building both networks can require substantial time and expenditure.
- Exclusive contracts can further restrict the entrant's access to restaurants, limiting its ability to offer a useful service.
- If restaurants can use several platforms and customers can switch easily, entry may become more credible.
- The incumbent might improve price or quality to retain users, but the extent depends on the entrant's financing, service and ability to reach scale.
Watch out for this
A market is competitive whenever creating a company is legally possible.
Entry must also be economically viable. Access, sunk investment, switching costs and network scale can matter.
Check your understanding
Which evidence most directly strengthens potential competitive pressure?
- The incumbent has a colourful logo.
- A capable entrant can access essential inputs and buyers can switch at low cost.
- All suppliers are tied to permanent exclusive contracts.